A Seemingly Simple Issue: The Legal Differences Between Starting a Business Alone or with Partners
The difference is probably bigger than you think.
Deciding whether to start a business on your own or with partners seems like a basic threshold question. But sometimes what might seem like a simple concept can have major legal implications. For startups and small businesses, a single-owner business is relatively basic to start, but as soon as there are more owners involved, there are instantly more issues that need to be dealt with.
Whether you are solo or have partners you will want to protect yourself by filing as a limited liability company (LLC) or a corporation. The benefits of limited liability protection are well-documented and there is almost no good reason not to do it. If you’re going to make money with a business, you should file as an LLC or a corporation and keep your business assets separate from your personal. Period.
Most people starting new businesses will start an LLC. It’s much simpler and cheaper than a corporation. If you’re starting an LLC alone or with partners – termed “members” in an LLC – then you’ll need to file articles with the state (usually very simple), obtain an Employee Identification Number from the IRS (a little more complex), and get an Operating Agreement.
LLC Operating Agreement
The Operating Agreement is where the real difference in “solo vs. partners” comes in. Operating Agreements are wonderful documents that set out all of the ways the business will be run. State laws have defaults in how LLCs will operate but you will almost certainly want something better than the default rules. Most state laws allow you nearly unlimited leeway in changing the default LLC rules and your Operating Agreement is where you put this information.
If you’re a solo business, then your Operating Agreement can be very simple, and you can just use a basic form. When you’re solo, the operating agreement is essentially an agreement between you and yourself. Banks will want to see this document verifying ownership.
However, with multiple members things get complicated quickly. An LLC with multiple members is a bit like a marriage – but instead of navigating much of the interaction with your spouse through loving trial and error and a lot of give and take, the duties, strategies, and rules of a business partnership can be decided early and clearly. And like some marriages – business partnerships can end in divorce. One of the most important things your Operating Agreement will cover is what happens if things go wrong, from a member wanting to leave, being forced out, or even what happens if a member dies.
The Operating Agreement will cover how ownership is structured and who will run what parts of the company. It should also deal with the differing time commitments and financial commitments of the members. In one case, the member who invests money may be paid back in the form of a loan with interest. On the other hand, the member working the business daily, may be paid reasonable compensation. There are myriad ways to structure these issues.
A good Operating Agreement will cover at least all of the following and likely quite a bit more:
Capital contributed by the members and the return of capital
Member’s compensation, time commitments and duties
Who will manage the company and limitations stating when they need approval from the others members
Intellectual property to be assigned to the company
Scope of the purpose of the company and how to avoid conflicts of interests
Who can loan money to the company and on what terms
Who gets paid from profits, when, and cash reserve requirements
When to dissolve the company and who gets what’s left
Restrictions on transfer of ownership
Right of first refusal when one member wants to sell
Mediation or other methods of conflict resolution
What happens if a member dies or becomes incapacitated
Covenants to the company like noncompetition and confidentiality
When and how to declare a forfeiture of a member’s ownerships interest
Deciding on these topics and making sure you have the right terms in place will be crucial to the early and long-term success of your business. Do this before you make the “legal” commitment. Speaking with an attorney that is experienced with drafting Operating Agreements will be crucial to ensuring a properly set up LLC.
To speak to an attorney at Anthony Law about your Operating Agreement, contact Scott Brown.